Term Sheet

What Is a Term Sheet?

A Term Sheet is a document that outlines the broad terms of a business deal. In Australia, it is most commonly used when startups are raising capital from investors. Think of it as the blueprint for the final contract. It sets out the commercial relationship between the parties before the lawyers get involved to draft the detailed legal agreements.

Under Australian common law, a Term Sheet is usually what is called a "Heads of Agreement". This means most of the document is non-binding. The parties are not legally forced to complete the deal just because they signed the Term Sheet. Instead, it shows a serious intent to proceed. It allows the startup and the investor to agree on the big picture, such as how much money is being invested and how much of the company the investor will own, before spending money on legal fees.

However, not every part of a Term Sheet is non-binding. Australian contract law is strict. If the document looks like a contract and the parties intend to be bound by it, a court may enforce it. To manage this risk, the document must explicitly state which clauses are legally binding and which are just an expression of intent.

Usually, the clauses dealing with confidentiality, exclusivity, and who pays the costs are binding immediately. The rest of the terms, such as the valuation and board seats, are usually non-binding until the final agreements are signed.

When to Use This Document

The most common time to use a Term Sheet in Australia is during a capital raise. This typically happens during seed rounds or Series A funding rounds for startups. When a venture capitalist or an angel investor wants to invest, they will present a Term Sheet to the founder. This document serves as the offer letter.

Business owners might also use this document in other scenarios. These include joint ventures, mergers and acquisitions, or significant commercial partnerships. For example, if a construction company is partnering with a technology firm to build a new platform, a Term Sheet can outline the project scope, equity split, and intellectual property ownership before the main Joint Venture Agreement is drafted.

It is important to distinguish a Term Sheet from a Letter of Intent. In Australia, these terms are often used interchangeably, but a Letter of Intent is sometimes less formal and may not detail the commercial terms as deeply. If you are negotiating specific investment mechanics like liquidation preferences or anti-dilution rights, a formal Term Sheet is the better tool.

Startups should be aware that the industry practice in Australia generally sees the Lead Investor drafting the initial Term Sheet. However, sophisticated founders do not simply accept this as is. They often negotiate the terms based on the Australian Investment Council (AIC) model documents to ensure a fair outcome.

Key Sections and Required Elements

A well-drafted Term Sheet needs specific sections to be effective. The research brief highlights several industry standards that should be included to protect both parties under Australian law.

Investment Terms

This is the core financial part of the document. It must specify the valuation of the company. A common mistake in Australian deals is failing to distinguish between pre-money and post-money valuation. This confusion leads to disputes over how much equity the founder gives away.

You must also state the "Instrument Type". In Australia, professional investors typically use Preference Shares for venture capital deals. Alternatively, the investment might be structured as a Convertible Note or, increasingly, a Simple Agreement for Future Equity (SAFE). SAFEs are popular but are not native Australian instruments, so they require careful drafting to fit within the Corporations Act 2001.

This section should also record the amount of money being invested and the percentage of equity the investor receives in return.

Company Governance

Governance terms define how the company will be run after the investment. This section covers the Board of Directors. You need to outline the total number of seats and who has the right to appoint them. Usually, the investor gets a seat, and the founders retain the majority at the early stages.

You may also include provisions for Board Observers. These are people who can attend board meetings and see the information but do not have a vote. This section should also list "Veto Rights". These are specific decisions the investor can block, such as changing the nature of the business or issuing new shares that would dilute their ownership.

Investor Protections

Investors use this section to reduce their risk. Key protections include:

• Liquidation Preference: This determines who gets paid first and how much if the company is sold or wound up. The standard in the Australian venture capital industry is "1x non-participating". This means the investor gets their money back first before the founders get anything from the sale proceeds.
• Anti-Dilution: This protects the investor if the company raises money later at a lower valuation. It adjusts the price the investor paid previously to match the lower price. The most common version is the "Broad-Based Weighted Average", which is fairer to founders than a "Full Ratchet".
• Tag-Along Rights: If a majority shareholder (usually a founder) sells their shares, this clause allows minority investors to join the deal and sell their shares at the same price.

Conditions Precedent

These are the "hoops" that must be jumped through before the investment becomes legally binding. Common conditions include the satisfactory completion of due diligence, the signing of definitive agreements like a Share Subscription Agreement, and necessary approvals from the company's existing board.

Binding Clauses

As mentioned earlier, the document must clearly identify which clauses are legally binding. These typically include:

• Confidentiality: This requires the parties to keep the deal terms and sensitive business data secret. This is particularly important given the Privacy Act 1988 (Cth) governs how personal information is handled during due diligence.
• Exclusivity (No-Shop): This stops the startup from looking for other investors for a set period, usually four to six weeks.
• Costs: This states who pays for the legal and due diligence costs. In Australia, it is common for each party to pay their own costs, but startups should check this carefully.

How to Write a Term Sheet (Step by Step)

Writing a Term Sheet requires a clear head and a focus on the main commercial points. You should not try to draft the final legal contract at this stage.

Step 1: Define the Parties and Purpose

Start by identifying who is involved. List the investors, the company, and the company's ACN (Australian Company Number). Clearly state that this document is a Term Sheet intended to outline the terms of a proposed investment.

Step 2: Determine the Valuation and Funding

Write down exactly how much money is being offered. Be precise with the valuation. Write "Pre-Money Valuation" and "Post-Money Valuation" in dollar figures and percentages. This prevents the "valuation ambiguity" mistake mentioned in industry research.

Decide on the investment structure. If you are using Preference Shares, specify the class of shares. If you are using a SAFE or Convertible Note, reference the specific terms such as the discount rate or valuation cap.

Step 3: Outline Governance and Control

Decide how the board will look. Will the investor have a seat? Will they have a veto? List the specific matters that require investor consent. Be realistic here. Asking for veto power over minor operational decisions will likely kill the deal.

Step 4: Insert Binding and Non-Binding Statements

This is the most critical legal step. You must include a clause that says something to the effect of: "Except for the clauses labelled as binding, this Term Sheet is non-binding and subject to the execution of a definitive agreement."

Mark the Confidentiality, Exclusivity, and Costs clauses as binding.

Step 5: Include Exclusivity Periods with Care

If the investor asks for a "No-Shop" clause, ensure there is a clear end date. Do not agree to an open-ended exclusivity period. A standard period is 4 to 6 weeks. This gives them time to do due diligence without freezing your ability to raise funds if they pull out.

Step 6: Add Disclaimers

If you are a platform provider or an advisor drafting this for others, or even if you are a founder, include a disclaimer. State that the document does not constitute legal or financial advice. This helps manage liability under the Corporations Act 2001 regarding financial services.

Common Mistakes to Avoid

When drafting or negotiating Term Sheets in Australia, several pitfalls frequently trip up business owners.

Ambiguity on Valuation

The most common cause of friction is failing to clarify if a valuation is pre-money or post-money. A $5 million investment on a $10 million valuation seems straightforward. But if the $10 million is pre-money, the investor owns 33 percent. If it is post-money, the investor owns 50 percent. Always write it explicitly.

Signing Without a Break Fee

If you grant an exclusivity period to an investor, you effectively take your company off the market. If that investor drags their feet and walks away at the last minute, you have lost time and momentum. Where possible, negotiate a "break fee" or a deadline that forces the investor to proceed or walk away.

Ignoring Employee Share Schemes

Sometimes, Term Sheets include provisions for an Employee Option Plan (ESS). If you are setting this up, you must ensure it complies with the Corporations Act 2001 (Division 83A) and relevant tax rulings (such as TR 2021/1). Getting this wrong can lead to nasty tax bills for your employees later on.

Personal Guarantees

In small business contexts, investors might ask directors to sign personal guarantees. This means if the company fails, the director is personally liable. This undermines the limited liability protection of a company structure. You should think very carefully before agreeing to this.

Using "Shall" Instead of "Intends"

The language you use matters. Using words like "shall" or "agree" can create a binding contract even if you label the document as non-binding. Use softer language like "intends to", "proposes", or "targets" for the commercial sections.

Legal Considerations (AU)

Navigating the legal landscape is essential when using a Term Sheet in Australia.

Corporations Act 2001

While the Term Sheet is often exempt, the final deal is heavily regulated. If you are issuing shares to the public or to more than 20 investors, you generally need a disclosure document under Chapter 6D of the Corporations Act. However, most startups rely on exemptions. The "small scale offering" exemption allows you to raise up to $2 million from no more than 20 investors without a disclosure document. There are also exemptions for "sophisticated investors" and "professional investors".

If you are using a SAFE, remember that this is a foreign concept. You need to ensure it fits within Australian fundraising laws. A poorly drafted SAFE might be interpreted as a security that requires a disclosure document, putting you in breach of the law.

Privacy Act 1988

A Term Sheet triggers the due diligence phase. During due diligence, investors will want to see your books, customer lists, and employee contracts. This involves disclosing personal information. As a business, you must ensure that your data handling during this phase complies with the Australian Privacy Principles (APPs). You are allowed to disclose information for the due diligence purpose, but you should ensure the investor also agrees to handle that data confidentially.

Financial Services Licence

If you are a platform or a consultant creating these Term Sheets for a fee, you must be careful. Providing a document that facilitates a financial product could be seen as providing a financial service. Under the Corporations Act, you generally need an Australian Financial Services Licence (AFSL) to do this, unless you rely on a specific exemption. Always include a disclaimer that the document is a template and does not constitute legal or financial advice.

Employee Share Schemes (ESS)

If the investment round includes an expansion of the option pool for staff, the structure must comply with tax laws. The Australian Taxation Office (ATO) has specific rules about when employees are taxed on options. To allow employees to defer tax, the ESS must meet certain criteria. Ensure your Term Sheet references that the option plan will be compliant.

Frequently Asked Questions

Is a Term Sheet legally binding in Australia?

Generally, no. It is usually an expression of intent. However, specific clauses regarding confidentiality, exclusivity, and costs are almost always legally binding. Additionally, if the document is drafted poorly and looks like a completed contract, a court might find the whole thing binding.

Do I need a lawyer to review a Term Sheet?

It is highly recommended. Even though the document is non-binding, it sets the commercial terms for the binding contracts that follow. Once you sign the Term Sheet, you have agreed to the valuation and the investor rights. Negotiating after signing is much harder.

What is the difference between a Term Sheet and a Share Subscription Agreement?

A Term Sheet is a summary of the deal terms. It is short and usually non-binding. A Share Subscription Agreement is the formal legal contract that actually transfers the money and the shares. It is long, detailed, and legally binding.

Can I use a US-style SAFE in Australia?

Yes, but with caution. Australian lawyers often modify the US Y Combinator SAFE to ensure it works with Australian company law and the Corporations Act. You should not use a standard US template without having an Australian lawyer review it first.

What happens if I break the exclusivity clause?

If you sign a Term Sheet with a binding "No-Shop" clause and then talk to other investors, you could be in breach of contract. The first investor could sue you for damages or seek an injunction to stop you from taking other money.

Who usually pays for the legal fees?

There is no strict law on this, but standard practice varies. In many Australian venture deals, each party pays their own legal costs. However, sometimes the startup may agree to pay the investor's legal costs if the investment amount is over a certain threshold. Check the "Costs" clause carefully.

What is a liquidation preference?

It is a clause that determines the payout order in a sale or wind-up. A "1x non-participating" preference means the investor gets their initial investment back before the founders get anything. If there is money left over, the founders then get their share.

How long should the exclusivity period be?

Typically, 4 to 6 weeks. This gives the investor enough time to complete due diligence without locking your company up for months.

Do I need to disclose financial information during the Term Sheet phase?

Yes, investors will request this for due diligence. Ensure you have a Non-Disclosure Agreement (NDA) in place, usually within the binding clauses of the Term Sheet, to protect your trade secrets.

Is a Term Sheet required for all capital raises?

No, it is not legally required. For very small, simple investments from friends or family, you might go straight to a subscription agreement. However, for any professional investment, it is standard practice to use one to align expectations.